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[TTHQ Staff]

BEING STREET SMART
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Sy Harding


THEY SHOPPED TIL THEY DROPPED! May 11, 2007.

Major retailers reported their April sales numbers this week and they were dismal. An index of the 51 largest retail chains reported a collective 2.3% decline in same-store sales, the worst monthly showing for that index since 1970.

Some of the declines were stunning. Sales at WalMart declined 3.5% in April, its largest monthly decline in 28 years. J.C. Penney’s sales fell 4.7%. Sales at Ann Taylor plunged 12.8%, and at Abercrombie & Fitch 15%. The younger generation’s favorites, Aeropostale and The Gap, saw sales plunge 15% and 16% respectively.

That is not good news for the economy. Consumer spending has been the economy’s main support, accounting for 65% of Gross Domestic Product (GDP) since the 2001 recession.

Back in 2002 Washington pulled out all the stops after the 9/11 terrorist attacks to encourage consumers to spend heavily, in an effort to pull the economy out of the 2001 recession. The incentives included tax refunds, tax rebates, and the lowest interest rates in 40 years. It was hoped if consumers got the ball rolling that corporations would begin spending again and soon pick up their share of the load.

But corporations did not step up to the plate. Capital spending on plants and equipment continued to be a disappointment.

So the need to carry the load remained with consumers. And they came through with flying colors. Their resilience has surprised everyone. They continuously found new ways to fund spending. They ran their savings down to negative numbers. They ran credit card debt into the stratosphere. They abandoned the age-old American dream of owning their home free and clear, instead refinancing mortgages to take as much equity as possible out of their homes. They bought cars with previously unheard of no down-payments and five and six-year loans. They bought homes with no down-payments and interest-only mortgages.

Even as gasoline prices shot up, consumers continued to spend more. Even as headlines warned of the real estate bubble bursting in 2006, consumers showed no concern. Retail sales continued to be the shining light in the darkness of the slowing economy.

It left bewildered economists muttering, warning that there had to be a breaking point.

Meanwhile, the economy has already slowed faster than surprised economists have been able to lower their forecasts. Growing at more than a 5% annual rate a year ago, it had slowed to just 2.5% growth by the 4th quarter of last year. And it slowed to just 1.3% growth at the end of the 1st quarter of this year. That’s approaching negative growth (a recession) at a very rapid pace.

Now the dramatic decline in retail sales in April gets the 2nd quarter off to a bad start.

But that wasn’t all of the bad news. Also on Thursday, the Commerce Department reported that the U.S. trade deficit unexpectedly spiked up a huge 10.4% in March, after six months of improvement. The trade deficit is a drag on the U.S. economy. So the government’s previous estimate that GDP grew only 1.3% in the March quarter, will probably be revised down even further as a result of this new information.

As might be expected, the stock market did not like those reports of dismal April retail sales, and a spike-up in the trade deficit. They raise the odds significantly that the economy may easily continue slowing all the way into recession.

So the Dow closed down 147 points on Thursday. The Russell 2000 index of small stocks plunged almost 2%. And there were more than three times as many stocks down as up on both the NYSE and the Nasdaq. It was the worst day since during the February-March correction earlier in the year.

But this market doesn’t worry about bad news for long. Already forgetting about Thursday’s news, the market was back up Friday morning, loving Friday’s report on inflation. The Producer Price Index rose 0.7% in April, a significant increase. However, if you take out the rising cost of food and gasoline to get to the so-called ‘core rate’, prices didn’t go up at all. (That would be good news if we didn’t have to eat, and if cars, trucks, and airplanes didn’t burn fuel).

Investors apparently hoped that if inflation pressures subside, the Fed may cut interest rates sometime this year and save the economy. They have short memories.

It takes a long time for interest rate changes to filter down into the economy and reverse its direction. History is full of examples, even the history of the last two recessions.

The Fed began cutting interest rates in January, 1990 in an effort to prevent that slowing economy from sliding into recession. As usual, it was too late. The 1990 recession took place after the rate cuts began. It took a total of 18 cuts in a row, until late 1991 before the Fed was satisfied that the economy was recovering again.

The Fed began cutting rates in January, 2001 in an effort to prevent that slowing economy from slowing all the way into recession. Again too late. The 2001 recession took place anyway. The Fed cut rates a total of 13 times that time before it was satisfied the economy was turning around.

So investors now are expecting that all will be well for the economy, and a recession can be avoided, if only the Fed will give us a rate cut or two later in the year? Dream on.



Sy Harding is president of Asset Management Research Corp., publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.